Have you ever wondered why and how there are so many private art museums in the United States: The Brant Foundation, The Broad, The Warehouse?
Let’s posit the obvious immediately: wealthy people with philanthropic objectives.
This however is a tax blog, meaning there is a tax hook to the discussion.
Let’s go through it.
We already know that the tax Code allows a deduction for charitable contributions made to a domestic corporation or trust that is organized and operated exclusively for charitable purposes. There are additional restrictions: no part of the earnings can inure to the benefit of a private individual, for example.
Got it: charitable and no sneak-arounds on the need to be charitable.
How much is the deduction?
Ah, here is where the magic happens. If you give cash, then the deduction is easy: it is the amount of cash given, less benefits received in return (if any).
What if you give noncash? Like a baseball card collection, for example.
Now we have to look at the type of charity.
How many types of charities are there?
Charities are also known as 501(c)(3)s, but there several types of (c)(3)s:
· Those that are publicly supported
· Those that are supported by gifts, dues, and fees
· The supporting organization
· The nonoperating private foundation
· The operating private foundation
What happens is that the certain noncash contributions do not mix will with certain types of (c)(3)s. The combination that we are concerned with is:
· Capital gain property (other than qualified stock), and
· The nonoperating private foundation
· What is capital gain property?
Property that would have generated a long-term capital gain had it been sold for fair market value. Say that you bought $25,000 of Apple stock in 1997, for example, when it traded at 25 cents per share.
By the way, that Apple stock would also be an example of “qualified stock.”
· What is not capital gain property?
The easiest example would be inventory to a business: think Krogers and groceries. A sneaky one would be property that would otherwise be capital gain property except that you have not owned it long enough to qualify for long-term capital gains treatment.
· What is a nonoperating private foundation?
The classic is a family foundation. Say that CTG sells this blog for a fortune, and I set up the CTG Family Trust. Every year around Thanksgiving and through Christmas the CTG family reviews and decides how much to contribute to various and sundry charitable causes. Mind you, we do not operate any programs or activities ourselves. No sir, all we do is write checks to charities that do operate programs and activities.
Why do noncash contributions not mix well with nonoperating foundations?
Because the contribution deduction will be limited (except for qualified stock) to one’s cost (referred to as “basis”) in the noncash property.
Say that I own art. I own a lot of art. The art has appreciated ridiculously since I bought it because the artist has been “discovered.” My cost (or “basis”) in the art is pennies on the dollar.
My kids are not interested in the art. Even if they were interested, let’s say that I am way over the combined estate and gift tax exemption amount. I would owe gift tax (if I transfer while I am alive) or estate tax (if I transfer upon my death). The estate & gift tax rate is 40% and is not to be ignored.
I am instead thinking about donating the art. It would be sweet if I could also keep “some” control over the art once I am gone.
I talk to my tax advisor. He/she tells me about that unfortunate rule about art and nonoperating foundations.
I ask my tax advisor for an alternate strategy.
Enter the operating foundation.
Take a private foundation. Slap an operating program into it.
Can you guess an example of an operating program?
Yep, an art museum.
I set-up the Galactic Command Family Museum, donate the art and score a major charitable contribution deduction.
What is the museum’s operating program?
You got it: displaying the art.
Let’s be frank: we are talking about an extremely high-end tax technique. Some consider this to be a tax loophole, albeit a loophole with discernable societal benefits.
Can it be abused? Of course.
How? What if the Galactic Command Family Museum’s public hours are between 3:30 and 5 p.m. on the last Wednesday of April in leap years? What if the entrance is behind a fake door on an unnumbered floor in a building without obvious ingress or egress? What if a third of the art collection is hanging on the walls of the CTG family business offices?
That is a bit extreme, but you get the drift.
One last point about the deduction if this technique is done correctly. Let’s use the flowing example:
The art is worth $10,000,000
I paid $ 1,000
We already know that I get a $10,000,000 charitable deduction.
However, what becomes of the appreciation in the art – that is, the $9,999,000 over what I paid for it? Does that get taxed to me, to the museum, to anybody?